Upload
allajunaki
View
218
Download
0
Embed Size (px)
Citation preview
7/31/2019 gordon model
http://slidepdf.com/reader/full/gordon-model 1/16
StrategicCorporate
Finance
Presented by: SHEETAL A. JAIMALANI(52)SHRIJESH K. GOVINDAN(55)KSHITIJ TIWARI(26)NEHA RAWAL(34)
7/31/2019 gordon model
http://slidepdf.com/reader/full/gordon-model 2/16
Dividend Theories
Relevance Theories
(i.e. which consider
dividend decision to be
relevant as it affects thevalue of the firm)
Irrelevance Theories
(i.e. which consider dividend
decision to be irrelevant as it
does not affects the value of the firm)
Walter’s Model Gordon’s Model
Modigliani and
Miller’s Model
7/31/2019 gordon model
http://slidepdf.com/reader/full/gordon-model 4/16
• According to Prof. Gordon, Dividend Policy almostalways affects the value of the firm. He Showed howdividend policy can be used to maximize the wealth of the shareholders.
• The main proposition of the model is that the value of ashare reflects the value of the future dividends accruingto that share. Hence, the dividend payment and itsgrowth are relevant in valuation of shares.
• The model holds that the share’s market price is equalto the sum of share’s discounted future dividendpayment.
7/31/2019 gordon model
http://slidepdf.com/reader/full/gordon-model 5/16
Definition
• A model for determining the intrinsic value of a
stock, based on a future series of dividends that
grow at a constant rate. Given a dividend per share
that is payable in one year, and the assumption that
the dividend grows at a constant rate in perpetuity,the model solves for the present value of the infinite
series of future dividends.
• Because the model simplistically assumes a constant
growth rate, it is generally only used for mature
companies (or broad market indices) with low to
moderate growth rates.
7/31/2019 gordon model
http://slidepdf.com/reader/full/gordon-model 6/16
Assumptions of the model:
• The firm is an all equity firm. No externalfinancing is used and investment programmes arefinanced exclusively by retained earnings.
• Return on investment( r ) and Cost of equity(Ke
)are constant.
• The firm has perpetual life.
• The retention ratio, once decided upon, isconstant. Thus, the growth rate, (g = br) is alsoconstant.
• Ke > br
7/31/2019 gordon model
http://slidepdf.com/reader/full/gordon-model 7/16
Arguments of this model:
• Dividend policy of the firm is relevant and that investors put a
positive premium on current incomes/dividends.• This model assumes that investors are risk averse and they put a
premium on a certain return and discount uncertain returns.
• Investors are rational and want to avoid risk.
•The rational investors can reasonably be expected to prefer currentdividend. They would discount future dividends. The retained
earnings are evaluated by the investors as a risky promise. In case
the earnings are retained, the market price of the shares would be
adversely affected.
• Investors would be inclined to pay a higher price for shares on
which current dividends are paid and they would discount the
value of shares of a firm which postpones dividends.
• The omission of dividends or payment of low dividends would
lower the value of the shares.
7/31/2019 gordon model
http://slidepdf.com/reader/full/gordon-model 8/16
P=E(1 - b)Ke - br
Where:P = Price of a share
E = Earnings per share
b = Retention ratio
1 - b = Dividend payout ratio
Ke = Cost of capital or the capitalization rate
br (or)g = Growth rate
According to Gordon, the market value of a share is
equal to the present value of the future streams of
dividends.
7/31/2019 gordon model
http://slidepdf.com/reader/full/gordon-model 9/16
Case A Case B
D/P Ratio 40 30
Retention
Ratio60 70
Cost of
capital
17% 18%
r 12% 12%
EPS $20 $20
P =$20 (1 - 0.60)
0.17 – (0.60 x 0.12) => $81.63 (Case A)
P =$20 (1 - 0.70)
0.18 – (0.70 x 0.12)=> $62.50 (Case B)
7/31/2019 gordon model
http://slidepdf.com/reader/full/gordon-model 10/16
Real Estate Bubble
Gordon’s growth model to calculate the value of a sample house.
• Apartment Size: 1800 Sq ft
• Rent Per month in that location: Rs. 19,000
•
Rental Advance: 10 times or Rs. 190,000• Assuming an increase of 15% rental every year, and an Inflation Rate
of 10%, the value of the apartment is Rs. 41,80,000.
• Present value of Interest earned on Rs 190,000 in perpetuity at 15% is
Rs 5,70,000. Total Value of the house is Approximately Rs. 47,50,000.
• The current price of the apartment is Rs. 80,00,000 (approximately).
• So Gordon model is used here to show that the house is overpriced.
7/31/2019 gordon model
http://slidepdf.com/reader/full/gordon-model 11/16
Pepsi
• Pepsi yields approximately 3.30% with a current
annual dividend of approximately $2 a share.
• Over the long term, no company can grow faster
than the gross domestic product. The long-termaverage growth in the gross domestic product of
the United States, which is 3%. The cost of equity
is 6%.• Using Gordon’s growth model, Pepsi’s stock has a
valuation of $69 a share.
7/31/2019 gordon model
http://slidepdf.com/reader/full/gordon-model 12/16
CitiGroup
• With these factors in mind, we will assume thatCitigroup is in stable growth, and that its currentearnings (estimated for 2000) of $ 13.993 billion
will grow 5% in perpetuity. In addition, we willassume that the payout ratio looking forward willbe 56.40% (the average modified payout ratioover last 4 years) and that the beta for the stock
based upon its business mix is 1.00. With theseinputs, a risk free rate of 5.1% and a risk premiumof 4%.
7/31/2019 gordon model
http://slidepdf.com/reader/full/gordon-model 13/16
• Cost of equity for Citigroup
= 5.1% + 1.00 (4%) = 9.1%
• Value of Citigroup’s equity
= $13.993 (1.05) (.564)/(.091-.05)
= $202.113 billion
7/31/2019 gordon model
http://slidepdf.com/reader/full/gordon-model 14/16
P = 83.248
0.1672 – 0.05 => Rs. 710.3
EPS 75.68
Divident 110%
75.68* 1.1= 83.248Ke 16.72%
G 5 %
Canara Bank
7/31/2019 gordon model
http://slidepdf.com/reader/full/gordon-model 15/16
Stock price calculated from the Gordon growth model is 710.30
The current market price for 52 week is 667.90 which can reach
710.3 if the current dividend growth of 5% is continued.
Canara Bank